The Eclairs v JKX case and “proper purpose” – the impact for directors


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The Companies Act 2006 requires directors to use their powers only for the purposes for which they have been conferred, also known as for the “proper purpose”. The statute does not give any guidance as to what this duty requires of directors in practice, but a recent Supreme Court case, Eclairs Group Limited v JKX Oil & Gas Plc [2015] UKSC 71, decided in December last year, has provided some useful pointers. The key lessons from the case are as follows:

  • Directors should be aware that the ability to take certain steps under statute or a company’s articles of association, particularly those that effectively restrict shareholder decision-making or autonomy, may be “a power”. The use of such a power must be considered carefully to avoid it being the subject of later challenge.
  • It may not be “proper” to exercise a power that is “technical” in nature, for example, a power to require information from shareholders on their shareholdings, where the directors’ overriding objective is to prevent shareholders taking certain actions in relation to the company, or making their views on its business known.
  • If the matter does end up in court, the “purpose” may be the subject of extensive investigation and examination. In accordance with good practice, contemporaneous board minutes or written resolutions should record the board’s rationale for all key decisions, but note that even if the board considers a matter fully and it is properly put on record, this will not validate a purpose that was “improper” from the start.
  • Acting for a mixture of purposes may invalidate a decision of the board. One bad motive may undermine multiple good ones.
  • Directors must be mindful of balancing their duty to do their best for the company generally, and to act in good faith, against specific duties such as the “proper purpose”. Even if the directors feel that they are trying to achieve the optimal result for the company, pursuing a certain course of action at all costs to the extent of, for example, disenfranchising shareholders, is unlikely to be the correct balance.

The duty to properly exercise powers

A director must balance a range of legal duties owed to the company of which he or she is a director. One of the less clearly-defined and less well-understood duties is in section 171(b) of the Companies Act 2006: the duty to “only exercise powers for the purposes for which they are conferred”, sometimes known as the duty of directors only to use their powers for a “proper purpose”.

The difficulty for directors is knowing exactly what this duty requires from them in practice when they make decisions. Not only does the Companies Act not provide any guidance on what is meant by exercising powers “for the purposes for which they were conferred” (or “properly”), it does not even specify what is meant by “powers”. What exactly, then, are directors required to do (or to ensure that they do not do) to comply with this duty?

In part because this duty developed from years of common law cases before it found its way into statute, real-life scenarios can provide practical guidance. Many historical cases concerned quite “mainstream” corporate powers such as the power to issue shares; it was thought “improper” if an issue was carried out to shift voting power within a company by diluting certain shareholders. The Supreme Court recently heard a case about the exercise of another sort of power.

A recent example of a misused power: Eclairs v JKX

The Eclairs v JKX case concerned notices sent by a public company at the direction of the directors, pursuant to section 793 Companies Act 2006 and a parallel, similar power in the company’s articles of association. The company had written to shareholders to ask them to disclose information as to holdings of its shares. Under both the Companies Act 2006 and the articles, the company had the power to impose penalties for non-compliance with (or incorrect responses to) such a request (in part, such sanctions are designed to allow listed public companies to comply with the disclosure obligations imposed by stock exchanges).

JKX’s board believed that certain shareholders were working behind the scenes to replace the company’s senior management team, and suspected that those shareholders might also be seeking to reduce the value of the company to allow it to be acquired at a discounted price.

The JKX directors considered that a significant proportion of responses received were partly or entirely inaccurate or incomplete. The directors therefore resolved to sanction the senders of those responses by taking away their right to vote at an upcoming annual general meeting.

The view of the Court of Appeal was that it was, bluntly put, the recipients’ own fault if they did not reply to the notices fully and candidly. They would need to suffer the consequences of any lack of full and frank disclosure accordingly. With that in mind, and because there was no limitation under section 793 or JKX’s articles on the power to impose sanctions, the Court of Appeal said that disenfranchising the suspected rebel shareholders was not an improper exercise of the power.

The Supreme Court disagreed. Rather than the behaviour of any recipients of the notices, the motivation of the directors was key. It was not enough simply for the directors to be honest or for them to act in good faith, nor for them to do what they thought best for the company as a whole.

This meant that it could not “save” their action that the JKX directors apparently honestly believed the company was being targeted by corporate raiders against its best interests. The board’s immediate, specific rationale for exercising the relevant power was, instead, paramount. Whilst a “proper purpose” could conceivably include punishing shareholders for not responding to company information requests properly, it did not, all things considered, extend so far as seeking to influence the result of an upcoming general meeting. In addition, some of the judges, at least, considered the use of the word “only” in the codified duty as significant. An illegitimate aim amongst a number of legitimate ones might be sufficient to negate a board of directors’ agreed (and properly resolved) course of action.

Conclusion

Directors need to consider, at all times, why exactly they are using their powers, and particularly, in the light of this case, where they are using such powers to take action against the shareholders of the company they direct. The valid aim of “protecting the company” does not give directors carte blanche to severely sanction shareholders for technical breaches. A court will look at whether the directors are really using their powers in order to avoid a particular result: for example, preventing the passing of a particular resolution at a shareholders’ meeting. That is not a “proper purpose”.

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